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					           Chapter 4

    Statement of Cash Flows
Operating, Investing, and Financing
             Activities
                         Cash Flow Statement
                         Cash From Operations
                         Cash From Investing
                         Cash From Financing
                         -------------------------------------

                         End. Cash                                End Balance Sheet
Beg Balance Sheet        – Beg. Cash

Assets   Liabilities                                             Assets   Liabilities
Cash                                                             Cash
.        Equities            Income                              .        Equities
.        .                   Statement                           .        .
         Retained            Revenue                                      Retained
         Earnings            .                                            Earnings
                             Expenses
                             ..
                             -----------------------------

                             Net income

                       End Ret Earnings
                       = Beg Ret. Earnings + Net
                       Income - Dividends
                                 Why Focus on Cash?
Because investors, creditors, and other interested parties want
to now what is happening to a company’s most liquid asset,
CASH.

The Statement of Cash Flow helps to evaluate:
1. The entity's ability to generate future cash flows.
2. The entity's ability to pay dividends and meet obligations
3. The reasons for the difference between net income and net
cash provided (used) by operating activities.
4. The investing and financing transactions during the period.
                         Statement of Cash Flows
helps answer the following questions:
• How did cash increase when there was a net loss for the
  period?
• Is cash flow greater or less than net income?
• How was the expansion in the plant and equipment
  financed?
• How was the the debt retired?
• How much money was borrowed during the year?
• What amount was paid in dividends?
                 Sources of Information for the
                      Statement of Cash Flows

The cash flow statement is a created statement that relies on
information from the income statement and balance sheet.
Wealth, financial value, and economic income don’t affect the
cash flow statement.
Therefore, to prepare the cash flow statement, you need:
» Current income statement (only current year)
» Comparative balance sheet (2 years)
» Additional information
    Statement of Cash Flows - components
The cash flow statement provides information about the
company’s
   – cash receipts and cash payments
   – the net change in cash resulting from:
     • operating,
     • investing, and
     • financing activities
     of a company during a period.
                                Operating Activities
– captures the effects operating transactions (i.e., normal
revenues and expenses transactions) have on the company’s
cash flow.

Income Statement Information Needed:
 Net income
 Depreciation and amortization (non-cash expense)
 Gain on sale of assets or investments (non-operating income)

Balance Sheet Information Needed:
 Change in Current Assets
 Change in Current Liabilities
        Examples of Cash Flows - Operating
Cash inflows:                    Activities
 – From sale of goods or services
 – From interest paid but not dividends received
Cash outflows:
 – To suppliers for inventory
 – To employees for services
 – To government for taxes
 – To lenders for interest
 – To others for expenses
                                  Investing Activities
Investing activities - captures a company’s purchase and sale
of assets and its use of cash to acquire a long-term investment
position in another company and the sale of these investments.

Income Statement Information Needed :
  – Gain (Loss) of Assets

Balance Sheet Information Needed :
  – Change in Long-Term Assets
     • Property Plant and Equipment
     • Long-Term Investments
         Examples of Cash Flows - Investing
Cash inflows:                     Activities
  – From sale of property, plant, and equipment
  – From sale of debt or equity securities of other entities
  – From collection of principal on loans to other entities
Cash outflows:
  – To purchase property, plant, and equipment
  – To purchase debt or equity securities of other entities
  – To make loans to other entities
                                   Financing Activities
Financing activities - captures a company borrowing and
repaying long-term loans and selling or buying back shares of
its own stock. In addition, it reflects any dividends paid by the
company.

Income Statement Information Needed:
  None
Balance Sheet Information Needed:
 Change in Long-Term Liabilities
 Change in Stockholders’ Equity
Retained Earnings Statement Information:
 Dividends Paid
         Examples of Cash Flows - Financing
                                  Activities
Cash inflows:
  – From issuance of equity securities (company's own stock)
  – From issuance of debt (bonds and notes)
Cash outflows:
  – To stockholders as dividends
  – To stockholders to buy back stocks
  – To redeem long-term debt or reacquire company’s stock
                Significant Non-Cash Activities
Transactions that do not affect cash are NOT reported in the
    body of the statement of cash flows. However, these items
    are reported:
» In a separate schedule at the bottom of the statement of
    cash flows or
» In a separate note or supplementary schedule to the financial
    statements.
Examples
• Issuance of common stock to purchase assets.
• Conversion of bonds into common stock.
• Issuance of debt to purchase assets.
• Exchanges of plant assets.
                     Cash Flow Statement – Two methods
Direct Method:
Shows all the cash inflows and outflows directly directly:
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

+ Collections from customers
…
- Paid to suppliers
…
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Cash Flow from Operations

We will focus only on the Indirect Method.
Shows why Net Income is different from Cash Flow from
Operations
The Indirect Method - 1

                             Current Liabilities
Cash
                             + Non Current Liabilities
+ Other Current Assets   =   + Retained Earnings
+ Non Current Assets
                             + Other Equities



          Rearrange          Current Liabilities
                             - Other Current Assets
                             + Non Current Liabilities
Cash                     =   - Non Current Assets
                             + Other Equities
                             + Retained Earnings
The Indirect Method - 2
                                          Increase in
                                          Current Liabilities
                                          - Other Current Assets
Increase in
                                          + Non Current Liabilities
Cash
                                =         - Non Current Assets
                                          + Other Equities
                                          + Retained Earnings

                                                   Roughly
                                                   Cash Flow from

                   Current Liabilities             Operations
                  -  Other Current Assets          Operations
                  +  Non Current Liabilities       Financing
              =
                  -  Non Current Assets            Investing
                  +  Other Equities                Financing
                  +  Retained Earnings             Operations
                   Converting Net Income to
                  Cash Flow From Operations
Accrual Method          Cash Method

                         Net Income
Revenue Earned
- Expenses incurred     + Noncash expenses
                        (e.g, depreciation)
Net Income
                         - Increases in Current Assets
                         + Increases in Current Liabilities

                         - Nonoperating income



                         Cash Flow From operations
                                  Cash Flow Example
Assume that Hart Co. has a beginning cash balance of $20,000
and an ending cash balance of $244,000. In addition, for the
year Hart Co. has net income of $200,000 and depreciation and
amortization of $15,000.
What impact does this information have on the cash flow
statement?
Hart's Total Cash Flow =
Ending Cash Balance $244,000
- Beginning Cash Balance $20,000 = $224,000.

The cash flow statement will show how this $224,000 increase
was achieved.
Sum of cash flow from operations, investing, and financing will
be $224,000.
                Depreciation and Amortization
The $15,000 of depreciation is a non-cash expense, so that
amount must be added to net income.
The goal is to go from net income (accrual basis) to “net
income” on the cash basis.
Therefore, we need to increase net income by $15,000,
since we have “overstated” our cash expenses by the amount
of depreciation.
Hart Co. Company
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2004
Cash flows from operating activities
 Net income                               $200,000
 Depreciation & amortization                15,000
Cash flow from operations                 $215,000
                                       Impact of Change in
                        Accounts Receivable (Current Asset)
Assume that Hart Co. had sales of $385,000 and all of its sales
are on credit. The beginning balance in accounts receivable
was $42,000 and the ending balance is $55,000. What impact
does this have on the cash flow statement?
                            Accounts Receivable
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

1/1                                                                                                                42,000
Sales                                                                                                            $385,000
Cash Collections                                                                                                                                          372,000
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12/31                                   55,000
Notice that the income statement reports $385,000 as sales.
However, we only collected $372,000 of it in cash. Thus, we
need to reduce net income by the increase in the accounts
receivable.
Hart Co. Company
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2004
Cash flows from operating activities
Net income                                $200,000
Depreciation & amortization                  15,000
Increase in accounts receivable            (13,000)

Cash flow from operations                 $202,000
                                        Impact of Change in
                          Accounts Payable (Current Liability)
Assume that Hart's operating expenses reported in the income
statement were $185,000, of which $170,000 were
expenditures requiring the future outlay of cash (i.e., other
than depreciation). The beginning balance in accounts payable
was $25,000 and the ending balance is $35,000.
                             Accounts Payable
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

1/1                                                                                                                                                      25,000
Expenses Incurred                                                                                                                                       170,000
Cash Payments                                                                                                  160,000
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

12/31                                                                                                                                                       35,000
 Hart Co. Company
 Statement of Cash Flows—Indirect Method
 For the Year Ended December 31, 2004
Cash flows from operating activities
Net income                                                                                                                                                  $200,000
Depreciation & amortization                                                                                                                                    15,000
Increase in accounts receivable                                                                                                                              (13,000)
Increase in Accounts payable                                                                                                                                   10,000
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net cash flow from operations                                                                                                                               $212,000
                             Cash Flow from Investing Activities
Add (subtract) the changes in the non-current asset accounts
(i.e., property, plant, and equipment) . An increase (decrease)
in property, plant, and equipment is a decrease (increase) in
cash flow.

Hart Co. acquired $40,000 of equipment for cash and
Hart Co. sold equipment with original cost $32,000 and
accumulated depreciation $12,000 for $25,000 cash.
The gain on sale
$5,000 =           $25,000         - $20,000
Gain =             Sales price     - Book Value
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Book Value =                                          original cost                                    - accumulated depreciation
$12,000                                               $32,000                                          - $12,000
                                   Analysis of Impact
The purchase of equipment is a cash outflow and the sale of
the equipment is a cash inflow.
The sale of equipment also affects the accrual basis income
statement, since the gain on the sale is included in net income.
Since we are creating a cash flow statement, the gain must be
removed from net income (see operating activities section) and
the cash flow from this transaction (e.g., $25,000) is reported
in the investing activities section.
 Hart Co. Company
 Statement of Cash Flows—Indirect Method
 For the Year Ended December 31, 2004
Cash flows from operating activities
Net income                                                                                                                                                  $200,000
Depreciation & amortization                                                                                                                                    15,000
Increase in accounts receivable                                                                                                                              (13,000)
Increase in Accounts payable                                                                                                                                   10,000
Gain on sale of equipment                                                                                                                                     (5,000)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Cash flow from operations                                                                                                                                   $207,000

Cash flows from investing activities:
Sale of equipment                                                                                                                                             $ 25,000
Purchase of equipment                                                                                                                                         (40,000)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Cash flow from investing                                                                                                                                      (15,000)
         Cash Flow from Financing Activities
Add (subtract) the changes in the debt accounts
Add (subtract) the changes the stockholders’ equity accounts.
Assume that Hart Co. borrowed $40,000 from Explorer bank
and paid $8,000 in dividends to its shareholders.
Hart Co. Company
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2004

Net cash flow from operations                                                                                                                              $207,000
Net cash flow from investing                                                                                                                                (15,000)

Cash flows from financing activities:
Cash from long-term borrowings                                                                                                                                    40,000
Payment of dividends                                                                                                                                             (8,000)
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Net cash flow from financing                                                                                                                                      32,000

Net Increase (Decrease) in Cash                                                                                                                            $224,000
Cash at beginning of period                                                                                                                                  20,000
----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Cash at end of period                                                                                                                                      $244,000
                                  Company Life Cycle
All companies go through business phases. The whole business
might not go through each phase, but a segment of the
business or a product line of the business will experience these
phases. The phases are often referred to as the:
» introductory phase
» growth phase
» maturity phase
» decline phase.
The phase a company is in affects its cash flows.
             Introductory and Growth Phases
Introductory: To support asset purchases, the company
needs to issue stock or debt. Since the operations are just
starting, expect:
» cash from operations to be            __
» cash from investing to be             __
» cash from financing to be             __

Growth: The company is striving to expand its production and
sales. Expect:
» cash from operations to be         __
» cash from investing to be          __
» cash from financing to be          __
                    Maturity and Decline Phases
Maturity: The company’s sales and production begin to level
off. Thus, investing will consist of replacing some long-term
assets and selling others. Expect:
» cash from operations to be              __
» cash from investing to be               __
» cash from financing to be               __

Decline: The company’s sales and production begin to decline.
This phase is not true for the whole company, but will certainly
affect a segment of a company. Expect:
» cash from operations to be           __
» cash from investing to be            __
» cash from financing to be            __
                   Cash-Based Ratio Measures
 Accrual-based measures may allow too much management
  discretion.
 One disadvantage to the cash-based measures is that no
  published industry averages are readily available for
  comparison.
                                                    Liquidity
- is the ability of a business to meet its immediate obligations
One measure of liquidity is the current ratio.

A disadvantage of the current ratio is that it uses year-end
balances of current assets and current liabilities (may not be
representative of a company's position during most of the
year.) A ratio that partially corrects this is the

Current Cash Debt Coverage Ratio
= Cash provided by operations ÷ Average current liabilities

Since cash from operations involves the entire year rather than
a balance at one point in time, it is often considered a better
representation of liquidity on the average day.
                                                     Solvency
- is the ability of a firm to survive over the long term.
One measure of solvency is the debt to total assets ratio.

A measure of solvency that uses cash figures is the

Cash Debt Coverage Ratio
= Cash Provided By Operations ÷ Average Total Liabilities

This ratio measures a company's ability to repay its liabilities
from cash generated from operations.

				
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posted:12/13/2011
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